The Week wrote an opinion piece of a review of David Dayen’s book , Chain of Title. But, in the article written by Ryan Cooper, he discussed the penalities of securitization law in New York and federal if the securities (in this case mortgage loans that were sold to Wall Street to become a securitization trust) did not properly follow the original contract. From The Week:
Not many noticed while the bubble was going up, but after it collapsed and the recession took hold, millions of people fell into default on their mortgages. Dayen’s book follows three private citizens, Lisa Epstein, Michael Redman, and Lynn Syzmoniak, all of whom were sucked into the foreclosure machine after the economic crash of 2008. In desperation they began poking around their foreclosure documents, and found howling, inconceivable errors — being foreclosed on by a bank that did not own the mortgage, obviously impossible dates, missing signatures, and so on.
They investigated further, and found that their cases were by no means unique, they were just one of the tiny minority of people who bothered to contest their foreclosure. Practically every case they looked at had gargantuan holes in them. Others had it even worse — banks who had foreclosed on people whose mortgages were paid-up, or ones who had no mortgage at all. It turned out the banks had battalions of people committing systematic fraud. “Robo-signers” would attest to “personal knowledge” of homes, or forge others’ signatures, or falsely notarize documents, hundreds of times per day. The sheer speed meant that the documents were almost universally garbage, but on the rare instances a foreclosure was challenged, the banks would usually just come back later with a new set that was magically in order.
Epstein, Redman, and Syzmoniak became obsessed with the foreclosure disaster, and they joined with others to agitate for the government to step in and provide relief for homeowners. After awhile, they began to get some traction. All this obvious fraud gave the government enormous leverage. If a bank does not have proper chain of title, it is illegal to foreclose. Since it means the bank does not own the mortgage, it is theft. Under New York law, securities which did not properly follow the original contract (and they usually didn’t) would be void. And under federal tax law, income from securities without proper documentation could potentially be taxed at 100 percent. With those tools, the federal government could have easily used the threat of prosecution and taxes to force the banks to the negotiating table.
And of course, the Obama Administration agencies never bother to tax the big banks at 100% (not just settle, fine, or give non-deferred prosecutions) if income from securities didn’t have the proper documentation. Here is a brief excerpt of securitization:
The short story is that every securitization—including Fannie Mae and Freddie Mac securitizations—requires the creation and funding of a securitization trust that must take physical possession and control of the trust property on or before the closing date of the trust. The securitization trustee is the sole and exclusive legal title holder of the thousands of promissory notes, original mortgages and assignments of mortgage. This transfer of the trust property, the legal res, to the trust at or around the loan origination is a necessary condition precedent to a valid securitization. It is necessary for several reasons.
First, someone must be the “legal” owner of the mortgage loan. Only the legal owner of the loan has the legal right to sell mortgage-backed securities (“MBS”) to investors. Second, actual physical transfer of ownership is necessary because the cash flows that go from the homeowner through the securitization trust to the MBS purchasers are tax exempt. If the trust does not perfect legal title by taking physical possession of the notes and mortgages, the Internal Revenue Code, specifically 26 U.S.C. § 860G(d)(1), provides for a 100 percent tax penalty on those non-complying cash flows. Third, the legal ownership of the loans must be “bankruptcy remote” that is, because bankruptcy trustees have the right to reach back and seize assets from bankrupt entities, the transfer to the trustee must be clean and no prior transferee in the securitization chain of title can have any cognizable interest in the loans. For this reason, all securitization trusts are “special purpose vehicles” (“SPVs”) created for the sole purpose of taking legal title to securitized loans and all securitization trustees represent and certify to the MBS purchasers that the purchase is a “true sale” in accordance with FASB 140.
But it never happened. It is all a fantasy. No securitization trustee of any securitized mortgage loan originated from 2001 to 2008 ever obtained legal title or FASB 140 “control” of any securitized loan. That is part of the reason FASB changed Rule 140 on September 15, 2008, on the eve of the financial meltdown.
Which is why robo-signing and falsifying documents by banks occurred..
SECURITIZATION IN A NUTSHELL
The securitization of a mortgage loan involves multiple parties. They are:
(1) the Borrower;
(2) the Original Lender (whomever is across the closing table from the Borrower);
(3) the Original Mortgagee (could be either the Original Lender or a “nominee” for the mortgagee, namely, Mortgage Electronic Registrations Systems, Inc. (“MERS”);
(4) the “Servicer” of the loan as identified in the securitization “pooling and servicing agreement” (“PSA”) (this is usually a bank or any entity with “servicer” in its name);
(5) the “Sponsor” is an entity identified in the PSA and the first link in the securitization chain of title between the Original Lender and the other parties to the PSA;
(6) the “Depositor” is the second link in the securitization chain of title and the entity between the Sponsor and the securitization Trustee;
(7) the “Trustee” is the sole and exclusive legal title owner of the securitized loan, the entity that must take physical delivery of the securitized notes and mortgages in order for the securitization to be valid, and the entity that issues MBS certificates to the purchasers of the MBS; and
(8) The MBS purchaser. This is the investor who buys MBS in reliance on the representations from the Trustee that the Trustee has valid legal title to the securitized notes and mortgages and who receives tax-exempt income from this investment.
There are three general types of securitizations.
The first is public securitizations. These are registered with the SEC. A typical PSA registered with the SEC is found here. The vast majority of public securitizations are governed by New York law. All public securitizations specifically require that the Trustee accept physical delivery of the securitized notes and mortgages prior to the “closing date” of the securitization trust. In the linked securitization, the “Series 2004-B Trust,” the definitions show that the closing date was February 26, 2004. Section 11.4 indicates that the Series 2004-B Trust is governed by New York law. Section 2.02 and Exhibit N show that the Trustee certified physical receipt of the notes and mortgages before the closing date.
The second is government-sponsored entity (“GSE”) securitizations. These are in two subcategories: Fannie Mae and Freddie Mac securitizations.
The actual securitization documents for Fannie Mae securitizations are not public. Fannie Mae, however, publishes its securitization formshere. For a single-family, fixed rate loan originated prior to June 1, 2007, the following “Trust Indenture” applies. According to section 12.04 of the Trust Indenture, Fannie’s rights are governed by District of Columbia law. As you can see from the Trust Indenture, Fannie acts as both the “depositor/custodian” (in trust law parlance, the “settlor”) and the “trustee.” Exhibit C at the end of the Trust Indenture is the “Custodial Agreement.” In the Custodial Agreement, Fannie represents, like the public securitization trustees referenced above, that it has received both the original note and fully executed assignments of mortgage prior to the “Issue Date” of the MBS.
Like Fannie Mae securitizations, Freddie Mac securitization documents are not public. Also like Fannie Mae, although it takes some navigating, Freddie Mac posts its securitization forms (“Seller/Servicer Guides”) here. Section 2(d)(3) of the Freddie Mac Seller/Servicer Guides requires that Seller/Servicer of a Freddie Mac deliver a fully executed assignment of mortgage from the Seller to Freddie Mac. Freddie Mac formerly published on its website a search tool that allowed the user to determine the date of the Freddie Mac securitization trust and the date Freddie Mac acquired the mortgage. Here is an example. Section 11 of the Freddie Mac Custodial Agreementprovides that “United States” law, to be construed in accordance with New York law, governs Freddie Mac’s legal title to Freddie Mac securitized loans.
And here is the Federal Reserve’s press release on September 15, 2008:
Joint Press Release
Board of Governors of the Federal Reserve System
Federal Deposit Insurance Corporation
Office of the Comptroller of the Currency
Office of Thrift Supervision
For immediate release
September 15, 2008
Federal Banking Agencies Evaluating FASB’s Accounting Proposals
The federal banking agencies are evaluating the amendments to generally accepted accounting principles proposed today by the Financial Accounting Standards Board (FASB).
These proposals would amend Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (FAS 140), and FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities (FIN 46(R)).
The FASB’s proposed amendments would remove the concept of a qualifying special purpose entity (QSPE) from FAS 140. This would require that variable interest entities previously accounted for as QSPEs under FAS 140 be analyzed to determine whether they must be consolidated in accordance with FIN 46(R). The amendment also would revise the criteria for reporting a sale versus a financing.
The proposed amendments also would modify the guidance in FIN 46(R) for determining which enterprise, if any, would consolidate a variable interest entity and require additional disclosures. Banking organizations commonly use QSPEs and variable interest entities for securitization and other structured finance activities.
The Federal Reserve Board, Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, and Office of Thrift Supervision are evaluating the potential impact that these proposals could have on banking organizations’ financial statements, regulatory capital, and other regulatory requirements. The agencies expect to engage in discussions with banks, savings associations, and bank holding companies to review and understand fully the implications of the proposed amendments.
Last update: September 15, 2008